According to GuruFocus Guru Trades, on June 30, Mario Gabelli (Trades, Portfolio) and Ken Fisher (Trades, Portfolio) take a long position on Nike, Inc. (NKE). The company, a $67.12 billion market cap, has a trailing P/E ratio that indicates that the stock is fairly valued (25.9x vs 25.9x of industry mean). So one question arises: Why are these hedge fund managers betting on it?

So in this article, let's take a look at a model which is applicable to stable, mature, dividend-paying firms and try to find the intrinsic value of the stock. Although the model has a number of characteristics that make it useful and appropriate for many applications, it is by no means the be-all and end-all for valuation. The purpose is to force investors to evaluate different assumptions about growth and future prospects.

Valuation

In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.

Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model). With the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.

Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%. This is a very low rate because of today´s context. Since 1900, yields have ranged from a little less than 2% to 15%; with an average rate of 4.9%. So I think it is more appropriate to use this rate.

Because, for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.

G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

Calculation of Intrinsic Value

Year

Value

Cash Flow

Presentvalue

0

Div 0

0,96

1

Div 1

1,12

0,99

2

Div 2

1,29

1,02

3

Div 3

1,47

1,03

4

Div 4

1,65

1,03

5

Div 5

1,83

1,02

5

Terminal Value

146,61

81,15

Intrinsicvalue

86,23

Current share price

76,73

Final comment

Using a margin of safety, one should buy a stock when it is worth more than its price on the market (plus a margin: I recommend 20%). We found that intrinsic value is about 12% higher than share price, so we can conclude that the stock is fairly valued and it makes sense to hold the stock if you already bought it.

We have covered just one valuation method, and investors should not rely on it alone in order to determine a fair (over/under) value for a potential investment.

Hedge fund gurus have also been active in the company. Tom Gayner has also taken long positions in the second quarter of 2014.

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